Feb 09

Stimulus Discussion Over?

Posted by Kristjan Velbri | Posted in Economy, General, Politics | Posted on 09-02-2009

burning_moneyThe  leaders of the world run around telling everybody that now is the time for action and the time for discussion is over. The loudest plea for action comes from the new president of the United States, Barack Obama. Of course, in a time of crisis, immediate action is necessary. When a man gets shot, there is not debate over what to do because everyone knows that you need to get the bullet out and the wound closed.

When it comes to the economy, things are far more complicated. President Obama has put forth a stimulus package, titled American Recovery and Reinvestment Act of 2009, which weighs in at around $800 billion. Mr. Obama has repeatedly emphasized the need to invest in infrastructure, education and energy projects to get the economy going again. But according to the Congressional Budget Office cost estimate, only $92 billion would be spent fiscal year 2009 (ending in September 30, 2009), with another $225 billion spent in 2010 and another $159 in 2011. Furthermore, only around $70 billion of that would be spent on infrastructure.

The Obama stimulus package is clearly about Democratic pork, not stimulating the economy. And even though there is all this talk about renewable energy, only $18.5 B of would be spent on renewable energy and energy efficiency (according to the original plan outlined in the CBO report). And only $4.5 billion would be spent on modernizing the electrical grid, which is the backbone of any developed economy. In fact, it was the high energy prices that led to high inflation and decreased spending in 2008.

Clearly, right now is the time for discussion, not “bold” and “swift” action, especially when considering the span over which the money would be spent. It is important to remember that Obama is good with words, but that doesn’t necessarily mean that he and his administration knows what’s best for the economy as demonstrated by the CBO report.

Spending like there is not tomorrow

Imagine a situation where a man has a cardiac arrest. The doctor gives him two options: either stop smoking, start exercising and eating right; or take drugs that will make him feel better. Now, the obvious choice should be the first one and this is the only viable option in the long term. Taking pills won’t cure him, it will only make the pain go away for a while. Eventually, he is going to have to change his lifestyle.

The economies of the US and many Western countries face a similar decision – they can either cut spending and eliminate inefficient and unsuccessful state programs that are a drain to the state’s budget; or they can print new money, increase taxes and fees and sell more government bonds to finance their ever-increasing spending. Fortunately, the general public is not falling for Obama’s rhetoric and there is some real discussion over his plans in the media. But what we lack right now is a full out discussion over the soundness of Keynesian economics, which is the theory behind the whole spending concept.

Short term fix for a long term problem

The size of the US economy is around $14.3 trillion and spending $90 – 200 billion to stimulate the economy is a drop in the bucket. Financing this enormous recovery package is not going to be easy – the US government can’t really raise taxes, in fact, they are proposing the opposite. So the only two options left are issuing more government bonds or monetizing debt by printing new money. In essence, this is equal to taking away money from the public, thereby decreasing their ability to spend, but this is ignoring the fact that the stimulus package is intended to promote spending! So in essence they are taking the money away only to give it back again! This is like taking a hundred dollars from the right pocket, putting it into the left one and claiming you are wealthier. It’s preposterous!

Eventually the US is going to have to repay all that debt. During 2009, the US has to find buyers for $2.2 trillion dollars worth of Treasury bills and bonds (the size of the US budget for fiscal year 2008 was $2.979 trillion). This will drive the interest rate higher for commercial bonds and will further exacerbate the state of the US economy as companies will cut spending and lay off millions of people. In the short run, the stimulus package might work, although the odds for it happening are increasingly slim. In the long run, the US is deeply in trouble and needs to pull it’s act together by spending less, saving more and actually producing stuff, not only consuming it.

Outlook for the world

Even though I’ve been focusing on the US economy, the outlook for the world is pretty bleak as well. The bank bailouts have only had a mild effect on the economy and the financial sector, but they haven’t had a positive effect of the banks’ willingness to lend money, which is why these bailouts were given to them in the first place. This can be attributed to the “boldness and swiftness”, or in other words, blind impulsiveness. The packages were pushed through in a hurry and there wasn’t much debate about how the money should be used. In the case of the TARP, the outlook is even worse as the Treasury Department doesn’t have to tell anyone how the money has been used.

The economies of the world are interconnected and the whole world has gone through a simultaneous real estate boom and a successive crash. Due to the interconnectedness of the commercial banks, there is not really a great amount of hope out there, the credit market is cold as ice and the current trends point to a decrease in the amount of outstanding debt (meaning that more loans are paid back than are taken out).

More on the Greatest Depression in the coming days, when I will be looking at the data – unemployment numbers, GDP, auto sales, exports etc. Also, we’ll be taking a look a other countries’ statistics.

Further reading:
Arnold Kling: Against the Big Stimulus
Martin Fackler (NYT): Japan’s Big-Works Stimulus Is Lesson
Anthony Gregory: Jobs Government Creates, and Destroys
Richard Benson (FSN): Keynes, Upside Down

What are your thoughts on the stimulus package?


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Comments (2)

[...] from: Stimulus Discussion Over? Share and [...]

Great article!And thanks for the links at the end of the post, they make a nice companion to the article.